In his 1942 book, This Age of Fable, German free-market economist Gustav Stolper pointed out:

Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment the state assumed control of the monetary system…. A “free” capitalism with government responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits governmental interference to go. Money control is the supreme and most comprehensive of all government controls short of expropriation.

Even in the high-water mark of classical liberalism in the 19th century, practically all advocates of the free market and free trade believed that money was the one exception to the principle of private enterprise. The international monetary order of the last century, of which Wilhelm Roepke spoke in such glowing terms (see “Monetary Central Planning and the State, Part 29: The Gold Standard in the 19th Century,” Freedom Daily, May 1999), was nonetheless the creation of a planning mentality. The decision to “go on” the gold standard in each of the major Western nations was a matter of state policy.

A central-banking structure for the management and control of a gold-backed currency was established in each country by its respective government, either by giving a private bank the monopoly control over gold reserves and issuing banknotes or by establishing a state institution assigned the task of managing the monetary system within the borders of a nation. The United States was the last of the major Western nations to establish a central bank, but it finally did so in 1913.

That even the gold standard was a government-managed monetary system was succinctly explained by economist Michael A. Heilperin in his book Aspects of the Pathology of Money (1968):

Wherever gold was chosen as a monetary standard, the gold content of the national monetary unit was defined by law, and the central bank was entrusted with the maintenance of that gold parity. The means to that end was convertibility on the one hand and purchase of gold by the central bank in unlimited quantities at a fixed price, on the other. In other words, under a gold standard the price of gold in terms of national currency was stabilized and the central bank operated as a sort of “gold pool.” As the bank had to sell gold on demand, it had to keep a certain stock of gold and the relation of the gold to the note issue was also defined by law. Whenever the bank lost gold it had to restrict the note issue … and this was done by raising the rate of interest and restricting the discounts of bills of trade…. The reverse would happen when the central bank obtained gold…. To what extent and at what moment the appropriate central bank policy would be carried out, was largely a matter of judgment. It is true that the range of discretionary powers enjoyed by central banks were limited and that the principles of administrating the monetary system were very clear and simple, but the fact remains that the system was rather managed than automatic.

Melchior Palyi, in his book The Twilight of Gold, 1914—1936 (1972), highlighted this aspect of government-managed gold standards before the First World War:

A new approach developed under the leadership of the Bank of England in the late 1860s and early 1870s…. The practice of central banking had now evolved to the use of discretionary measures – that is, as far as “control” over short-term fluctuations in the balance of payments and in domestic credit conditions were concerned. Managerial discretion was essential to decide, for example, when and how to intervene in a panic by granting liberal credit at high interest rates in order to forestall forced liquidation of otherwise sound assets. Yet, the basic objective of discretionary policy was to try to prevent panic and dangerous gold drains and to be able to counteract them if they occurred…. When an active policy line was chosen, it became mandatory to induce the financial community, the commercial banks in particular, to coordinate their credit practices with those of the central bank…. Central bankers had to learn their profession; not only the quasi-mechanical rules of the game, but also the techniques of adapting them to immediate control objects.

In the 19th century there was a greater humility among those who constructed and implemented various government economic policies. There was a general agreement with Adam Smith’s observation that “the statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate, and which would nowhere be so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it.”

The classical liberals were deeply suspicious of government abuse of the printing press. They believed that only a monetary system under which all bank-issued notes and other claims were redeemable on demand for gold could act as a sufficient check against the abuse and debasement of a currency. Or as the English classical economist Nassau Senior summarized it: “The power to issue inconvertible paper [money] has never been granted or assumed without it sooner or later abused.”

But central-banking authorities were nonetheless given the authority and responsibility to manage the gold reserves at their disposal and the quantity of notes and other bank deposit claims outstanding to maintain the soundness of the monetary system and to counteract various short-term fluctuations in the national currency’s foreign-exchange rate, the balance of payments, and the quantity of financial credit available in the country’s economy. Their policy “tools,” as Heilperin and Palyi pointed out, included manipulation of short-term interest rates and the buying and selling of private-sector bills of trade and securities. The central bankers needed to “learn their profession” concerning “matters of judgment” about when to raise or lower interest rates and tighten or loosen available credit and how to “induce” private financial institutions to “coordinate” their own credit-issuing practices with those of the central bank, within “the range of discretionary powers enjoyed by central bankers.”

While the goals for monetary policy may have been considered modest and limited in the eyes of the classical liberals of the 19th century, it remained a fact that the monetary system was a subject for national government policy. In an era of relatively unrestricted free-market capitalism, money and the monetary system were a “nationalized industry.” And as such, even most of the advocates of economic liberty argued for monetary socialism and monetary central planning. They failed to call for and defend the privatization of the most important commodity in a market economy – the medium of exchange.

As a result, when economic collectivism, socialism, and interventionism gained popularity and power in the early decades of the 20th century, money was the one area in which the central-planning ideal was already triumphant. For a hundred years, it had been taken for granted that the state should have either direct or indirect monopoly control over the supply of money in the market. Or as Vera Smith explained in The Rationale of Central Banking (1936), “It is notable that when laissez faire theories and policies were at their height so far as other industries were concerned, banking was already regarded as in another category. Even the most doctrinaire free-traders … were unwilling to apply their principles to the business of banking. It was widely contended that banking must be the subject of some special regulations.”

In the decades after the First World War, the goals assigned to monetary central planning changed, but the instrument for their application remained the same – central bank management of the money supply. As we have seen, Yale University economist Irving Fisher advocated the stabilization of the price level. (See “Monetary Central Planning and the State, Part 2: The Rationale of a Stable Price Level for Economic Stability,” Freedom Daily, February 1997.) As Fisher stated in The Money Illusion (1928),

To stabilize the buying power of the monetary units has long been the dream of economists…. And since the volume of circulating credit is controllable and controlled [through the Federal Reserve central bank], we have already a managed currency in spite of ourselves. If we insure scientific management in place of hit-and-miss management we shall thereby attain stabilization.

John Maynard Keynes argued in his Tract on Monetary Reform (1923), “The war has affected a great change. Gold itself has become a ‘managed’ currency…. All of us from the Governor of the Bank of England downwards are now primarily interested in preserving the stability of business, prices and employment.” The goal of monetary central planning, in Keynes’s view, as he articulated it in the 1930s, was for monetary policy to support and facilitate government “aggregate demand management” for manipulating the economywide levels of employment and output. (See “Monetary Central Planning and the State, Parts 15—20,” Freedom Daily, March—August 1998.)

The Chicago school economists in the 1930s had argued for a fiat paper-money system directly controlled by the government, with the responsibility to manipulate the quantity of money for stabilization of the price level. (See “Monetary Central Planning and the State, Part 23: Henry Simons and the ‘Chicago Plan’ for Monetary Reform,” Freedom Daily, November 1998.) And later, Milton Friedman, as a leader of the Chicago School, also long advocated a paper-money system managed with a similar goal in mind. (See “Monetary Central Planning and the State, Parts 24—26,” Freedom Daily, December 1998—February 1999.)

In his Age of Fables, Gustav Stolper pointed out in 1942 that “there is today only one prominent [classical] liberal theorist consistent enough to advocate free, uncontrolled competition among the banks in the creation of money. [Ludwig von] Mises, whose intellectual influence on modern neo-liberalism was very strong, has hardly made one proselyte for that extreme conclusion.”

Now at the end of the 20th century, however, there has emerged a new generation of free-market critics of monetary central planning who are in favor of market money and private, free banking. Ludwig von Mises and Friedrich A. Hayek have been the inspiration for this new school of advocates for a free market in money.

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Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

Reading List

Prepared by Richard M. Ebeling

Austrian economics is a distinctive approach to the discipline of economics that analyzes market forces without ever losing sight of the logic of individual human action. Two of the major Austrian economists in the 20th century have been Friedrich A. Hayek, who won the Nobel Prize in Economics, and Ludwig von Mises. Posted below is an Austrian Economics reading list prepared by Richard M. Ebeling, economics professor at Northwood University in Midland and former president of the Foundation for Economic Education and vice president of academic affairs at FFF.